UN warns of ‘destabilizing’ effect of pension funds

21 June 2007

The United Nations (UN) has voiced concern about the impact growing activity of institutional investors, such as pension funds, might have on economies. Institutional investors weaken the control of monetary authorities over credit growth and limit the effectiveness of monetary policies as they largely operate outside of market regulation and supervision mechanisms that apply to banks, the UN stated in its latest edition of the World Economic and Social Survey entitled Development in an Ageing World.

'If unchecked, the financial market operations of pension funds could thus be a source of financial instability. Improved (international) regulatory measures are needed to avert possible financial market destabilizing effect of the operations of large pension funds and prevent the income security of older persons from being jeopardized.'

The UN pointed out that institutional investors were mostly not subject to the central banks' quantitative monetary controls such as reserve and liquidity requirements which 'makes It difficult for the monetary authority to conduct counter-cyclical policy'.

An increase in households investing in companies and other credit market instruments via their pension funds leads ' to a pro-cyclical wealth effect on household balances', the report says. This means that during economic upswings more money will be spent whereas a downturn leads to a decline in consumption and magnifies the swings of the business cycle.

However, the UN welcomed evidence suggesting institutional investors are contributing to the development and deepening of financial markets and they lead to 'enhanced sophistication of the financing mechanisms and a wider range of available instruments in the markets'.

But the fact institutional investors act mostly through secondary markets often contributes 'to increased volatility rather than to sustained economic expansion' especially in developing economies, the organisation said.

The UN added: 'The role of institutional investors in contributing to the volatility of capital flows and increasing the potential for systemic risk – raises questions about the stability of the global financial systems and the links forged between institutions and markets worldwide.'

One solutiond according to the UNd might be the introduction of capital controls which can help to offset the pro-cyclicality and volatility linked to capital flow.

Assets under management with institutional investors in developed economies have grown between 1990 and 2003 from $14trn (㈊.5trn) to $47trn. This equals an increase from 78% of the aggregated GDP of those countries to 160%

Related background paper:
The implications of aging for the structure and stability of financial markets
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